Thursday, June 7, 2007

IBM Moves Saves $1.6 Billion In Taxes

You have probably heard the saying before that high tax rates cause people to engage in behavior that enables them to avoid paying those taxes. Some of it illegal, some legal. When you do business in the US, with our 40% average corporate tax rate being the world's second highest, those efforts become pervasive. Take the recent case of IBM (IBM).


It involves "Repatriation" of profits. The simplest way to describe that is foreign subsidiaries of US companies, if their earning are included in the results of the parent company, have profits taxed here is the US at US corporate tax rates in addition to taxes they may be paying in the country they are based.

To Avoid This:

IBM formed a new IBM subsidiary in the Netherlands. The unit spent $1 billion in cash and $11.5 billion in borrowed funds to buy 118.8 million shares -- 8% of shares outstanding. They did this from a group of investment banks that had borrowed the shares from institutional investors. The investment banks will then return the borrowed shares with shares they buy on the open market over the next nine months. If its stock rises and the investment banks suffer losses, IBM will cover them.

The transaction was structured to let IBM buy back stock without repatriating retained earnings from its foreign units to the U.S.

IBM does not have cash hidden overseas. It plans to repay the loans to the banks used for the stock repurchase with future earnings from international subsidiaries in different countries. The estimated tax rate after various credits would be 22%. That would result in saving about $1.6 billion, compared to the taxes it would have incurred by repatriating the sums to the U.S. the person said.

Very sneaky, and until the IRS caught on and issued a notice on May 31st, very legal. Now let's not get all upset at IBM. People behave in ways based on the conditions they find themselves in. Now, had we had the EU taxes rate of 26%, IBM may not have even investigated this. Were we in the US taxed at the 12.5% those companies in Ireland are, the topic would not have come up. When you tax folks the most, they will find ways around it. Management at IBM has a fiduciary responsibility to their shareholder and a move like this only show they take that seriously.

Rather than giving IBM a "tisk-tisk", I am trying to find out if the multinationals in my portfolio have done the same thing and if not, ask, "who was sleeping in accounting?"

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